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USC Professor Swenson Makes His Case

Published in Fox & Hounds Daily:

California’s economy needs all the help it can get. It is barely growing. Its unemployment rate, at 12.5%, is the second highest in the nation. Yet in his budget-balancing proposal, Gov. Jerry Brown includes a money-saving idea that, if adopted, would kill a program that keeps more than 1 million Californians working and generates millions in tax revenues. He claims this program doesn’t significantly contribute to the state economy. The governor is wrong.

Begun in 1986, the state’s Enterprise Zone Program offers tax breaks and other incentives to more than 100,000 companies doing business in any of 42 designated areas with high unemployment and poverty rates. The zones range in size from 1.7 square miles to 671 square miles. And they boost local economic activity.

A recent example. Last year, Baxter International, a major pharmaceutical company, was weighing a plan to move its manufacturing facility in East Los Angeles out of state. Some 1,100 jobs were on the line. But the company changed its mind when an adjacent enterprise zone was enlarged to include its facility. Not only were jobs saved; Baxter also said it would create more by expanding the plant.

The success of enterprise zones rests on more than anecdotes. Two colleagues and I studied the economic performance of enterprise zones across the country. A few studies have shown that zones stimulate economic activity in some states, but the findings were more suggestive than definitive because researchers relied on ZIP codes, an imprecise tool, to define the boundaries of a zone. Using precise GIS mapping software, we examined the 20-year economic records of 1,200 zones in the 45 states where they exist.

The findings were unequivocal. Unemployment in enterprise zones was, on average, 1.6 percentage points lower than in similar areas with high rates of joblessness and poverty. Over 20 years, the poverty rate in enterprise zones dropped, on average, by 6.1 points, while household income – wages and salaries – grew by $700 annually.

The economic performance of California’s enterprise zones was even better. Joblessness, on average, was 3.4 percentage points lower than in comparable depressed economic areas, while the poverty rate in these zones declined, on average, by about 8.6 points over 20 years. Incomes – wages and salaries – rose, on average, by about $3,000 annually.

This finding directly contradicts the governor’s claim that enterprise zones do not significantly boost employment. Brown is largely relying on a study done by the Public Policy Institute of California. The study also used GIS software to map the state’s enterprise zones. But it measured employment in a different way, which made it more difficult to detect job gains, or losses, in enterprise zones.

The PPIC study defined companies’ workforces in terms of broad ranges — one to five employees for a small company, 50 to 75 for a larger one, and so on. As you can easily see, if a small company with three workers hires a fourth because of the tax breaks it receives for being in an enterprise zone, it would not register as a job gain. Only jobs that push a company into a new workforce range would be counted. This problem is amplified as you move up the company-size ladder and the associated range of workers broadens.

By contrast, the study I worked on used Census data, which reported job gains, or losses, in exact numbers. Employment changes could be more easily tabulated.

Put studies aside, however, and think of the issue this way. If eliminating an enterprise zone forces a business to downsize or move out of state — or if it keeps a company from relocating to California – the state loses tax revenues. This is not pocket change. Using data from The Tax Foundation, I estimate that businesses in California, on average, collectively pay about 21% of their profits annually in state and local taxes. Using the foundation’s data on individuals, I estimate that each employed worker annually pays about $2,000 a year in combined income and sales taxes.

It’s thus possible to see the potential loss in tax revenues of, say, 10% of businesses downsizing or closing once they lose their enterprise-zone tax breaks.

Or put it another way. If a worker loses her job, she can collect up to $23,000 in unemployment benefits in California. On average, a company operating in one of the state’s 42 enterprise zones receives a tax break of about $15,000 per qualified employee hired or retained. What possible economic sense is there in risking the loss of her $2,000 in annual taxes while gaining the burden of paying her $23,000 in jobless benefits for the sake of ending a $15,000 tax benefit?

When deficit-plagued Illinois faced the option of cutting its enterprise zone program, it decided instead to raise its income tax rates by 66%.

Solving California’s chronic budget problems will be a formidable task. But jettisoning a job-creating and -sustaining program to save less than an estimated $1 billion to help close a $25 billion gap is more likely to perpetuate the budget mess than clean it up – and keep the state’s economy crawling.

Charles W. Swenson is professor and Leventhal research fellow at the Marshall School of Business at the University of Southern California. His study on enterprise zones will appear in the forthcoming Journal of Public Economics.

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